The Chinese Currency Just Fell To A Key Level And Billions Of Dollars Are At Stake

A
clerk arranges bundles of 100 Chinese yuan banknotes at a branch
of China Merchants Bank in HefeiThomson Reuters

HONG KONG (Reuters) - China's
yuan fell beyond 6.20 to the dollar on Wednesday for the first
time since April last year amid market speculation the central
bank will keep the currency weak as economic growth slows.

The yuan has tumbled 0.8 percent so far this week after the
People's Bank of China (PBOC) on Saturday doubled the daily
trading band allowed for the currency to 2 percent from the
mid-point that it sets each day.

Spot yuan briefly fell as low as 6.2040 in early afternoon trade
before ending at 6.1965. That marked a 0.07 percent loss on the
day from Tuesday's close, and a fall of 1 percent from the
mid-point.

"We see risks of further near-term yuan weakness, but do not
expect this to extend beyond the second quarter. It is not in the
PBOC's interests to have a sustained depreciation in the
currency, as this will increase financial stability risks,"
economists at ANZ said in a research note.

Other analysts agreed that allowing the yuan to weaken too far,
too fast would only increase the stresses on Chinese companies
and the broader economy.

ANZ expects the currency to return to a modest appreciation trend
in the second half, but still end the year weaker for the first
time since Beijing unshackled it from its fixed exchange rate to
the dollar in 2005.

The currency has risen more than 30 percent since then,
attracting a growing number of global investors, big and small,
many of whom have come to see it as a one-way appreciation bet.

ANZ like many other market watchers has now dialed back
expectations for the yuan, revising its year-end yuan forecast to
6.08 from 5.98.

"The yuan may not appreciate this year given China's weak
economy," agreed one trader in Shanghai. "The return of yuan
strength will not only rely on when the economy bottoms out, but
when fresh long yuan funds come in."

While the recent slide in the yuan is widely seen as a move
engineered by the central bank to punish speculators, it has
coincided with heightened anxiety among global investors that
long-standing risks in China may be coming to a head.

The economy clearly lost steam in the first two months of the
year and rising debt worries following the country's first
domestic bond default are adding to pressure on its currency and
stock markets. A flurry of local media reports of troubled steel
and property companies have compounded market jitters.

Some traders suggested the yuan's decline may reflect
policymakers' desire to offer some help to the sluggish economy,
by effectively easing monetary conditions, while others said that
may only be a welcome side-effect of the PBOC's move to deepen
market reforms.

Speculation that Beijing may soon announce stimulus measures for
the economy has grown since data last week showed growth in
investment, retail sales and factory output all falling to
multi-year lows.

"The currency band widening at this moment has two advantages.
One is to signal that the reform agenda will not be easily given
up despite weak economic condition. Second, while band widening
itself has little impact on the economy, the possible consequence
could be used to stabilize growth," said Zhu Haibin, an analyst
at JP Morgan.

However, not all traders subscribe to that view. Others said the
yuan's decline reflected genuine trade as investors reduced long
positions in the currency as the PBOC looks to implement deeper
reforms.

They pointed to the fact that just two days into the 2 percent
band regime, the market had already moved the currency by the
equivalent of the previous band's 1 percent limit.

When the band was last widened in 2012 - to 1 percent from 0.5
percent - it took the market two weeks to build up the courage to
test even the previous band's width given how closely the central
bank controls the market.

Indeed, in recent weeks sentiment on the Chinese yuan had already
turned bearish for the first time since mid-2012 as the PBOC
rounded on speculators and looked to curb hot money inflows, a
Reuters poll showed last week.

A weaker currency could also work against exporters if it also
grows more volatile, raising their hedging costs.

OFFSHORE YUAN ALSO VULNERABLE

The yuan's decline reverberated offshore, where the currency's
non-deliverable forwards (NDFs) indicated further weakness to
come.

Deliverable yuan in Hong Kong fell to its lowest level since
April 2013, with traders predicting further weakness because
structured product positions could come under pressure.

Offshore yuan fell to 6.1995 per dollar in afternoon trade,
extending a streak that has seen it weaken by 2.6 percent in
nearly a month, wiping out its 2013 gains. It later regained some
strength and traded at 6.1855.

"Investors are deleveraging the yuan appreciation expectations in
the short-term following the band widening," said a dealer in
Hong Kong.

The fall in the offshore yuan spot rate to nearly 6.20 per
dollar, the lowest level in more than 11 months, is pressuring
lots of structured yuan products which were originally sold
around that level, pointing to the risk of a blowout on the
short-end volatility curve.

More than $300 billion of these structured products have been
sold since 2013 and the yuan's drop has raised the chances of
some of these products defaulting, adding another destabilizing
factor in the market.

Analysts say they expect further market reforms following the
widening of yuan band. The next meaningful reform would be for
Beijing to shift to a new market-based regime and away from
setting the daily yuan fixing.

As an intermediate step, China could peg the yuan to a basket of
currencies weighted by the importance of its trading partners. Lu
Ting, an analyst at Bank of America Merrill Lynch said that more
specifically, Singapore's so-called BBC regime, or basket, band
and crawl, seems to be favored.

In some countries where hungry investors have jumped into
yuan-related investment products, regulators are also expressing
concern about risks as the currency becomes increasingly adopted
worldwide.

South Korean regulators are inspecting units of four foreign
banks, sources told Reuters on Wednesday, as authorities worry
about systemic risks from the rapid growth in yuan-denominated
deposits. [ID:nL3N0MG0AC] In Taiwan, where the yuan accounted for
a fifth of the island's total foreign currency deposits in
January, regulators recently warned investors to expect more
volatility in yuan.

The yuan surpassed the Swiss franc to become the seventh
most-used world payments currency in January, global transaction
services organization SWIFT said.

The "redback" is now only ranked behind the U.S. dollar, euro,
sterling, yen, Canadian dollar and Australian dollar in terms of
global payments, according to SWIFT.